Creating Internal Capital

George B. Weathersby

Chairman & CEO, Genesys Solutions, LLC

Every organization needs financial capital to operate. Whether a for-profit corporation or a non-profit organization, finance is either the great enabler of or the limiting constraint on the activities of the organization. Especially in today's financial environment, the availability of enormous pools of venture capital, private equity and hedge funds have made it very tempting for executives and owners to look to external sources of capital to finance their growth. In many ways it is very tempting to ask parent organizations, investment advisors and bankers, donors and supporters to provide additional external capital. Seeking external capital is certainly easier than generating new capital from internal operations. Allocating new money among operating units is much easier than reallocating among units the surplus capital generated by individual operating groups. But is external derived capital better for the organization than internally generated capital?

External capital is often a one-time infusion of cash. The fees for raising or providing the capital often run between 10% and 20% of the total amount raised. Warrants and other equity enhancements are often required which dilute prior stockholders' interest and raise the cost of the new capital even further. There are often operating constraints included in covenants related to debt sources of external capital or constraints built into the prospectuses of equity offerings. These constraints often include restrictions on the liquidity of current shareholders, restrictions on dividends and compensation, imposition of new Directors on the Board, review and approval of major financial transactions, among many other conditions.

Internal capital is often a sustained improvement in cash flow from the same level of sales and prices. Increasing (or decreasing) the effective price per physical unit of goods sold (or the relevant measure of services provided) only impacts internally generated capital if it is a sustainable advantage (or disadvantage) in the marketplace. The primary source for sustainable internal capital is improved organizational execution, which is reflected in permanent improvements achieved in operations, in increased profitability, in reduced time to market, in increased rates of profitable innovation, etc. These benefits of improved organizational ability to execute are usually achieved without significant expenditures of capital or operating support.

Increased internal capital is an on-going source of cash, not a one-time transaction. The cost of achieving the future annuity-like stream of capital from improved execution is typically very low; our clients spend less than 1% of the annuity value they create. There is no dilution of shareholder equity; in fact, the market value of a firm will increase as its ability to generate increased internal capital is recognized in the market. There are no additional constraints on the operations of the firm; internal capital is produced without externally imposed covenants or restrictions. There are no restrictions on the use of the internally generated capital; unlike the constraints on the use of funds provided by external sources. With increased internal capital the role of the current Board is strengthened; there are no external constituents to impose constraints or limitations based on the increase of internal capital.

I cannot think of any circumstance in which thoughtful leaders of an organization would not prefer capital produced through improved execution instead of externally sourced capital--and yet the vast majority of organizations in my experience seek external capital without striving to improve execution and thereby provide a significant amount of the needed capital from internal sources. Why not?

One of our most distinguished clients, who in every other way led his world-class organization to produce superior performance and results, commented to me shortly after retiring as CEO that his greatest disappointment was that he could find no way to persuade business unit leaders to generate any internal capital for reallocation. Only when he agreed to allow the business units to redeploy within their units their internally generated capital would they achieve sizable efficiencies. In the end, he also sought external capital in large amounts and left to another leader the opportunity of "harvesting" the substantial capital that was clearly available internally.

Apparently, the vast majority of even our very best leaders in organizations of all types choose not to drive improved execution in order to produce serious amounts of internally sourced capital that can be reallocated to support the organization's primary objectives. Could it be that many senior executives do not know how to achieve sustainable improvements in execution?

Our clients have demonstrated significant improvements in their ability to execute and the financial results achieved from their organization's improved execution have confirmed it. Before you allow perceived limitation in capital to reduce your organization's opportunities for growth or responsiveness to your markets, would you like to understand better the magnitude of the internal capital you can create through improved execution? Give me a call and I would be delighted to share our experiences with you.

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Creating Internal Capital

George B. Weathersby



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